Bookkeeping is the process of tracking income and expenses in your business. It lets you know how you’re doing with cash flow and how your business is doing overall. Staying on top of your bookkeeping is important so that you don’t have unexpected realizations about account balances and expenses. We’ve put together this guide to help you understand the basics of small business bookkeeping.
Why Bookkeeping Is Important for Small Businesses
Bookkeeping is an essential task that you must undergo as a business owner. It’s important because:
- It organizes information: Bookkeeping takes financial data and organizes it for easy understanding and analysis.
- The IRS requires you to track certain information: When you do your taxes, you’ll need accurate information about your gross receipts, purchases, expenses, assets, travel and entertainment expenses and employment taxes.
- It helps in budgeting: Knowing the cash flow allows you to allocate resources to new launches and projects that will help your business grow.
- It provides better decision-making: When the books are in order, you have an accurate account of your business’s health. This allows you to make better decisions about operations and growth.
- It helps you track profit: Of course, you want your business to be as profitable as possible. Bookkeeping helps track your progress and profits.
Bookkeeping vs. Accounting
Though often confused for each other, there are key differences between bookkeeping and accounting. At its core, bookkeeping is about recording financial data, while accounting is about interpreting financial data. Accounting can’t happen without good bookkeeping. Without bookkeeping, there would be no data to analyze.
Generally speaking, bookkeepers help collect and organize data and may have certain certifications to do so for your business. On the other hand, accountants are generally equipped with an accounting degree and may even be state-certified CPAs. You can expect most bookkeepers to maintain the general ledger and accounts while the accountant is there to create and interpret more complex financial statements.
Key Components of Bookkeeping
Whether you do the bookkeeping yourself or hire someone to do it, certain elements are fundamental to properly maintaining the books. Some of these elements are done more regularly than others to ensure that the books are always up to date. Other elements are completed at certain time periods as necessary to complete a business task.
Recording Transactions
Bookkeepers use journal entries to record debits and credits. Every financial transaction should have a line item in the general ledger, which tracks everything in one place. The general ledger notates the account number to which the debit or credit is applied. The best accounting software automates a lot of the process in journal entries for regular debits and credits to help eliminate possible errors in data entry.
Sending Invoices
If not done at the time of the transaction, the bookkeeper will create and send invoices for funds that need to be collected by the company. The bookkeeper enters relevant data such as date, price, quantity and sales tax (if applicable). When this is done in the accounting software, the invoice is created, and a journal entry is made, debiting the cash or accounts receivable account while crediting the sales account.
Preparing Basic Financial Statements
Since the information gathered in bookkeeping is used by accountants and business owners, it is the basis of all the financial statements generated. Most accounting software allows you to automatically run common financial statements such as an income and expense statement, balance sheet and cash flow statement. Business owners or accountants can then use these statements to gain insight into the business’s financial health.
Completing Payroll
At the end of every pay period, the bookkeeper will accumulate employee payroll details that include hours worked and rates. From there, the total pay is determined with the applicable taxes and withholdings. Paychecks are completed and issued. In the accounting software, the primary journal entry for total payroll is a debit to the compensation account and credits cash.
Accounting Methods
There are two types of accounting methods to choose from: the cash method and the accrual method. You’ll want to select a method that helps you best manage your business’s finances.
Cash-Based Accounting
The first method of accounting is the cash-based accounting method. This method records financial transactions when money is exchanged. This means that you don’t record an invoice until it is actually paid. Similarly, you don’t notate outstanding bills until you actually pay them. This method offers a true snapshot of your assets and debts at any given time.
Accrual-Based Accounting
Another type of accounting method is the accrual-based accounting method. This method records both invoices and bills even if they haven’t been paid yet. This is a highly recommended method because it tells the company’s financial status based on known incoming and outgoing funds. Because the funds are accounted for in the bookkeeping, you use the data to determine growth.
Bookkeeping Tools and Software
There’s good news for business owners who want to simplify doing their books. Business owners who don’t want the burden of data entry can hire an online bookkeeping service. These services are a cost-effective way to tackle the day-to-day bookkeeping so that business owners can focus on what they do best, operating the business. For business owners who don’t mind doing the data entry, accounting software helps to simplify the process. You no longer need to worry about entering the double-entry data into two accounts. The software does it for you.
How To Manage Bookkeeping in 4 Steps
When doing the bookkeeping, you’ll generally follow the following four steps to make sure that the books are up to date and accurate. Remember that each transaction is assigned to a specific account that is later posted to the general ledger. Posting debits and credits to the correct accounts makes reporting more accurate. Take a look at the following four steps to manage your bookkeeping.
Assign Transactions to Specific Accounts
Look at the item in question and determine what account it belongs to. For example, when money comes from a sale, it will credit the sales revenue account. Making sure transactions are properly assigned to accounts gives you the best view of your business and helps you extract the most helpful reports from your bookkeeping software.
Perform Journal Entries to Debit and Credit Accounts
When manually doing the bookkeeping, debits are found on the left side of the ledger, and credits are found on the right side. Debits and credits should always equal each other so that the books are in balance.
Post Entries to Ledger Account
Once the entries are assigned to the correct accounts, you can post them to the general ledger to get a bird’s-eye view of your current cash status. Most accounting software does this for you, so you don’t need to worry about an extra step.
Adjust Entries at the End of Each Accounting Period
At the end of the accounting period, take the time to make adjustments to your entries. Adjustments make your books more accurate. For example, you may have estimated certain invoices that are later solidified with an actual number. Correct the entries to reflect accurate data.
Bottom Line
As a business owner, it is important to understand your company’s financial health. This all starts with having updated and accurate books. Bookkeeping puts all the information in so that you can extract the necessary information to make decisions about hiring, marketing and growth.
Article by Forbes
